PORTFOLIO MGT 100 MRKS PROJECT FOR BBI 5TH SEM

8/21/2019 PORTFOLIO MGT 100 MRKS PROJECT FOR BBI 5TH SEM

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1CHAPTER: 1

INTRODUCTION

1.1 MEANING OF PORTFOLIO MANAGEMENT

1.2 DEFINITIONS

1.3 MEANING OF PORTFOLIO MANAGERS

1.4 SCOPE OF PORTFOLIO MANAGEMENT

1.5 NEED FOR PORTFOLIO MANAGEMENT

1.6 OBJECTIVES OF PORTFOLIO MANAGEMENT

1.7 BASIC PRINCIPLES


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2Stock exchange operations are peculiar in nature and most of theInvestors feel insecure in managing their investment on the stock market

because it is difficult for an individual to identify companies which have

growth prospects for investment. Further due to volatile nature of the

markets, it requires constant reshuffling of portfolios to capitalize on the

growth opportunities. Even after identifying the growth oriented

companies and their securities, the trading practices are also complicated,

making it a difficult task for investors to trade in all the exchange and

follow up on post trading formalities.

Investors choose to hold groups of securities rather than single security

that offer the greater expected returns. They believe that a combination of

securities held together will give a beneficial result if they are grouped in

a manner to secure higher return after taking into consideration the risk

element. That is why professional investment advice through portfolio

management service can help the investors to make an intelligent and

informed choice between alternative investments opportunities without

the worry of post trading hassles.
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31.1 MEANING OF PORTFOLIO MANAGEMENT

Portfolio management in common parlance refers to the selection of

securities and their continuous shifting in the portfolio to optimize returnsto suit the objectives of an investor. This however requires financial

expertise in selecting the right mix of securities in changing market

conditions to get the best out of the stock market. In India, as well as in a

number of western countries, portfolio management service has assumed

the role of a specialized service now a days and a number of professional

merchant bankers compete aggressively to provide the best to high net

worth clients, who have little time to manage their investments. The idea

is catching on with the boom in the capital market and an increasing

number of people are inclined to make profits out of their hard-earned

savings.

Portfolio management service is one of the merchant banking

activities recognized by Securities and Exchange Board of India (SEBI).The service can be rendered either by merchant bankers or portfolio

managers or discretionary portfolio manager as define in clause (e) and

(f) of Rule 2 of Securities and Exchange Board of India(Portfolio

Managers)Rules, 1993 and their functioning are guided by the SEBI.

According to the definitions as contained in the above clauses, a

portfolio manager means any person who is pursuant to contract or

arrangement with a client, advises or directs or undertakes on behalf of

the client (whether as a discretionary portfolio manager or otherwise) the

management or administration of a portfolio of securities or the funds of

the client, as the case may be. A merchant banker acting as a Portfolio

Manager shall also be bound by the rules and regulations as applicable to

the portfolio manager.


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4Realizing the importance of portfolio management services, the SEBIhas laid down certain guidelines for the proper and professional conduct

of portfolio management services. As per guidelines only recognized

merchant bankers registered with SEBI are authorized to offer these

services.

Portfolio management or investment helps investors in effective and

efficient management of their investment to achieve this goal. The rapid

growth of capital markets in India has opened up new investment avenues

for investors.

The stock markets have become attractive investment options for the

common man. But the need is to be able to effectively and efficiently

manage investments in order to keep maximum returns with minimum

risk.

Hence this is the study on PORTFOLIO MANAGEMENT &

INVESTMENT DECISION so as to examine the role, process and

merits of effective investment management and decision.

1.2DEFINITIONS

DEFINITIONS OF PORTFOLIOA collection of various company shares, fixed interest securities or

money-market instruments. People may talk grandly of 'running a

portfolio' when they own a couple of shares but the characteristic of a

serious investment portfolio is diversity. It should show a spread of

investments to minimize risk - brokers and investment advisers warn

against 'putting all your eggs in one basket'.
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5DEFINITIONS OF PORTFOLIO MANAGEMENT

The process of managing the assets of a mutual fund, including

choosing and monitoring appropriate investments and allocating

funds accordingly.

DEFINITIONS OF PROJECT PORTFOLIOMANAGEMENT

PPM, short for project portfolio management, refers to a

software package that enables corporate and business users to

organize a series of projects into a single portfolio that will provide

reports based on the various project objectives, costs, resources,

risks and other pertinent associations. Project portfolio

management software allows the user, usually management or

executives within the company, to review the portfolio which will

assist in making key financial and business decisions for the

projects.

1.3 MEANING OF PORTFOLIO MANAGERS

Portfolio manager means any person who enters into a contract or

arrangement with a client. Pursuant to such arrangement he advises the

client or undertakes on behalf of such client management or

administration of portfolio of securities or invests or manages the clients

funds.

A discretionary portfolio manager means a portfolio manager who

exercises or may under a contract relating to portfolio management,

exercise any degree of discretion in respect of the investment or

management of portfolio of the portfolio securities or the funds of the

client, as the case may be. He shall independently or individually manage
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6the funds of each client in accordance with the needs of the client in amanner which does not resemble the mutual fund.

A non discretionary portfolio manager shall manage the funds in

accordance with the directions of the client.

A portfolio manager by virtue of his knowledge, background and

experience is expected to study the various avenues available for

profitable investment and advise his client to enable the latter to

maximize the return on his investment and at the same time safeguard the

funds invested.

1.4 SCOPE OF PORTFOLIO MANAGEMENT

Portfolio management is an art of putting money in fairly safe, quite

profitable and reasonably in liquid form. An investors attempt to find the

best combination of risk and return is the first and usually the foremost

goal. In choosing among different investment opportunities the following

aspects risk management should be considered:

a) The selection of a level or risk and return that reflects the investorstolerance for risk and desire for return, i.e. personal preferences.

b)The management of investment alternatives to expand the set ofopportunities available at the investors acceptable risk level.

The very risk-averse investor might choose to invest in mutual funds.

The more risk-tolerant investor might choose shares, if they offer higher

returns. Portfolio management in India is still in its infancy. An investorhas to choose a portfolio according to his preferences. The first preference

normally goes to the necessities and comforts like purchasing a house or

domestic appliances. His second preference goes to some contractual

obligations such as life insurance or provident funds. The third preference

goes to make a provision for savings required for making day to day

payments. The next preference goes to short term investments such as UTIunits and post office deposits which provide easy liquidity. The last choice


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7goes to investment in company shares and debentures. There are numberof choices and decisions to be taken on the basis of the attributes of risk,

return and tax benefits from these shares and debentures. The final

decision is taken on the basis of alternatives, attributes and investor

preferences.

For most investors it is not possible to choose between managing ones

own portfolio. They can hire a professional manager to do it. The

professional managers provide a variety of services including

diversification, active portfolio management, liquid securities and

performance of duties associated with keeping track of investors money.

1.5 NEED FOR PORTFOLIO MANAGEMENT

Portfolio management is a process encompassing many activities of

investment in assets and securities. It is a dynamic and flexible concept

and involves regular and systematic analysis, judgment and action. The

objective of this service is to help the unknown and investors with the

expertise of professionals in investment portfolio management. It involves

construction of a portfolio based upon the investors objectives,

constraints, preferences for risk and returns and tax liability. The portfolio

is reviewed and adjusted from time to time in tune with the market

conditions. The evaluation of portfolio is to be done in terms of targets set

for risk and returns. The changes in the portfolio are to be effected to meet

the changing condition.Portfolio construction refers to the allocation of surplus funds in hand

among a variety of financial assets open for investment. Portfolio theory

concerns itself with the principles governing such allocation. The modern

view of investment is oriented more go towards the assembly of proper

combination of individual securities to form investment portfolio.


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8A combination of securities held together will give a beneficial result ifthey grouped in a manner to secure higher returns after taking into

consideration the risk elements.

The modern theory is the view that by diversification risk can be

reduced. Diversification can be made by the investor either by having a

large number of shares of companies in different regions, in different

industries or those producing different types of product lines. Modern

theory believes in the perspective of combination of securities under

constraints of risk and returns.

1.6 OBJECTIVES OF PORTFOLIO MANAGEMENT

The major objectives of portfolio management are summarized as

below:-

1) Security/Safety of Principal: Security not only involves keepingthe principal sum intact but also keeping intact its purchasing power

intact.

2) Stability of Income: So as to facilitate planning more accuratelyand systematically the reinvestment consumption of income.

3) Capital Growth: This can be attained by reinvesting in growthsecurities or through purchase of growth securities.

4) Marketability: i.e. is the case with which a security can be boughtor sold. This is essential for providing flexibility to investment

portfolio.

5) Liquidity i.e. Nearness To Money: It is desirable to investor so asto take advantage of attractive opportunities upcoming in the

market.

6) Diversification: The basic objective of building a portfolio is toreduce risk of loss of capital and / or income by investing in various

types of securities and over a wide range of industries.


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97) Favourable Tax Status:The effective yield an investor gets form

his investment depends on tax to which it is subject. By minimizing

the tax burden, yield can be effectively improved.

1.7 BASIC PRINCIPLES

There are two basic principles for effective portfolio management which

are given below:-

I. Effective investment planning for the investment in securities byconsidering the following factors-

a) Fiscal, financial and monetary policies of the Govt. of India and theReserve Bank of India.

b) Industrial and economic environment and its impact on industry.Prospect in terms of prospective technological changes,

competition in the market, capacity utilization with industry and

demand prospects etc.

II. Constant Review of Investment: It requires to review theinvestment in securities and to continue the selling and purchasing of

investment in more profitable manner. For this purpose they have to

carry the following analysis:

a) To assess the quality of the management of the companies in whichinvestment has been made or proposed to be made.

b)To assess the financial and trend analysis of companies BalanceSheet and Profit and Loss Accounts to identify the optimum capitalstructure and better performance for the purpose of withholding the

investment from poor companies.

c) To analyze the security market and its trend in continuous basis toarrive at a conclusion as to whether the securities already in

possession should be disinvested and new securities be purchased.

If so the timing for investment or dis-investment is also revealed.


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10CHAPTER 2

PERSONS INVOLVED IN PORTFOLIO

MANAGEMENT

2.1 PORTFOLIO MANAGER

2.2 WHO CAN BE A PORTFOLIO MANAGER?

2.3 FUNCTIONS OF PORTFOLIO MANAGERS

2.4 NEED AND ROLE OF PORTFOLIO MANAGER

2.5 PORTFOLIO MANAGERS OBLIGATION

2.6 COORDINATION WITH RELATING AUTHORITIES

2.7 DEFAULTS AND PENALTIES


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112.1 PORTFOLIO MANAGER

Is a person who is in the wake of a contract agreement with a client,

advices or directs or undertakes on behalf of the clients, the management

or distribution or management of the funds of the client as the case may

be.

2.2 WHO CAN BE A PORTFOLIO MANAGER?

Only those who are registered and pay the required license fee are

eligible to operate as portfolio managers. An applicant for this purpose

should have necessary infrastructure with professionally qualified persons

and with a minimum of two persons with experience in this business and a

minimum net worth of Rs. 50lakhs. The certificate once granted is valid

for three years. Fees payable for registration are Rs 2.5lakhs every for

two years and Rs.1lakhs for the third year. From the fourth year onwards,

renewal fees per annum are Rs 75000. These are subjected to change by

the S.E.B.I.

The S.E.B.I. has imposed a number of obligations and a code of conduct

on them. The portfolio manager should have a high standard of integrity,


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12honesty and should not have been convicted of any economic offence ormoral turpitude.

He should not resort to rigging up of prices, insider trading or creating

false markets, etc. their books of accounts are subject to inspection to

inspection and audit by S.E.B.I... The observance of the code of conduct

and guidelines given by the S.E.B.I. are subject to inspection and penalties

for violation are imposed. The manager has to submit periodical returns

and documents as may be required by the SEBI from time-to- time.

2.3 FUNCTIONS OF PORTFOLIO MANAGERS

Advisory role:Advice new investments, review the existing ones,identification of objectives, recommending high yield securities etc.

Financial analysis: He should evaluate the financial statement ofcompany in order to understand, their net worth future earnings,

prospectus and strength.

Study of stock market :He should observe the trends at variousstock exchange and analysis scripts so that he is able to identify the

right securities for investment

Study of industry:He should study the industry to know its futureprospects, technical changes etc, required for investment proposal

he should also see the problems of the industry.

Decide the type of portfolio: Keeping in mind the objectives ofportfolio a portfolio manager has to decide whether the portfolio

should comprise equity preference shares, debentures, convertibles,

non-convertibles or partly convertibles, money market, securities

etc or a mix of more than one type of proper mix ensures higher

safety, yield and liquidity coupled with balanced risk techniques of

portfolio management.


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13A portfolio manager in the Indian context has been Brokers (Bigbrokers) who on the basis of their experience, market trends, Insider

trader, helps the limited knowledge persons.

The ones who use to manage the funds of portfolio, now being

managed by the portfolio of Merchant Banks, professionals like MBAs

CAs And many financial institutions have entered the market in a big

way to manage portfolio for their clients.

According to S.E.B.I. rules it is mandatory for portfolio managers to

get them selfs registered.

Registered merchant bankers can acts as portfolio managers.

Investors must look forward, for qualification and performance and

ability and research base of the portfolio managers.

2.4 NEED AND ROLE OF PORTFOLIO MANAGER

With the development of Indian Securities market and with

appreciation in market price of equity share of profit making companies,

investment in the securities of such companies has become quite

attractive. At the same time, the stock market becoming volatile on

account of various facts, a layman is puzzled as to how to make his

investments without losing the same. He has felt the need of an expert

guidance in this respect. Similarly non resident Indians are eager to make

their investments in Indian companies. They have also to comply with the

conditions specified by the RESERVE BANK OF INDIA under various

schemes for investment by the non residents. The portfolio manager with

his background and expertise meets the needs of such investors by

rendering service in helping them to invest their fund/s profitably.


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142.5 PORTFOLIO MANAGERS OBLIGATION

The portfolio manager has number of obligations towards his clients,

some of them are:

He shall transact in securities within the limit placed by the clienthimself with regard to dealing in securities under the provisions of

Reserve Bank of India Act, 1934.

He shall not derive any direct or indirect benefit out of the clientsfunds or securities.

He shall not pledge or give on loan securities held on behalf of hisclient to a third person without obtaining a written permission from

such clients.

While dealing with his clients funds, he shall not indulge inspeculative transactions.

He may hold the securities in the portfolio account in his own nameon behalf of his clients only if the contract so provides. In such a

case, his records and his report to his clients should clearly indicatethat such securities are held by him on behalf of his client.

He shall deploy the money received from his client for aninvestment purpose as soon as possible for that purpose.

He shall pay the money due and payable to a client forthwith. He shall not place his interest above those of his clients.

He shall not disclose to any person or any confidential informationabout his client, which has come to his knowledge.

He shall endeavour to:

oEnsure that the investors are provided with true and adequateinformation without making any misguiding or exaggerated claims.

oEnsure that the investors are made aware of the attendant risksbefore any investment decision is made by them.


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15oRender the best possible advice to his clients relating to his needs

and the environment and his own professional skills.

oEnsure that all professional dealings are affected in a prompt,efficient and cost effective manner.

2.6 COORDINATION WITH RELATING AUTHORITIES

The portfolio manager shall designate a senior officer as compliance

offer.

The senior officer:

Shall coordinate with regulating authorities regarding variousmatters.

Shall provide necessary guidance to and ensure complianceinternally by the portfolio manager of all Rules, Regulations

guidelines, Notifications etc. issued by SEBI, government of

India and other regulating authorities.

Shall ensure that observations made/ deficiencies pointed out bySEBI in the functioning of the portfolio manager do not recur.

2.7 DEFAULTS AND PENALTIES

The following aspects must be kept in view:

Liabilities for action in case of default - A portfolio manager isliable to penalties if he:

1. Fails to comply with any conditions subject to which certificate ofregistration has been granted.

2. Contravenes any of the provisions of the SEBI act, its Rules andRegulations.

In such a case, he shall be liable to any of the following penalties,after enquiry-

i. Suspension of registration for a specific period.ii. Cancellation of registration.


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16CHAPTER 3

TYPES OF PORTFOLIO MANAGEMENT

3.1 INVESTMENT MANAGEMENT3.2 IT PORTFOLIO MANAGEMENT3.3 PROJECT PORTFOLIO MANAGEMENT


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173.1 INVESMENT MANAGEMENT

Investment management is the professional management of various

securities (shares, bonds etc.) and assets (e.g., real estate), to meetspecified investment goals for the benefit of the investors. Investors may

be institutions (insurance companies, pension funds, corporations etc.) or

private investors (both directly via investment contracts and more

commonly via collective investment schemes e.g. mutual funds or

Exchange Traded Funds).

The term asset management is often used to refer to the investment

management of collective investments, (not necessarily) whilst the more

generic fund management may refer to all forms of institutional

investment as well as investment management for private investors.

Investment managers who specialize in advisory or discretionary

management on behalf of (normally wealthy) private investors may often

refer to their services as wealth managementor portfolio management

often within the context of so-called "private banking".

Fund manager (or investment adviser in the U.S.) refers to both a

firm that provides investment management services and an individual

who directs fund management decisions.

3.2 IT PORTFOLIO MANAGEMENTIT portfolio managementis the application of systematic management

to large classes of items managed by enterprise Information Technology

(IT) capabilities. Examples of IT portfolios would be planned initiatives,

projects, and ongoing IT services (such as application support). The

promise of IT portfolio management is the quantification of previously

mysterious IT efforts, enabling measurement and objective evaluation of

investment scenarios.


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18The concept is analogous to financial portfolio management, but thereare significant differences. IT investments are not liquid, like stocks and

bonds (although investment portfolios may also include illiquid assets),

and are measured using both financial and non-financial yardsticks (for

example, a balanced scorecard approach); a purely financial view is not

sufficient.

At its most mature, IT Portfolio management is accomplished through

the creation of two portfolios:

(i) Application Portfolio - Management of this portfolio focuses oncomparing spending on established systems based upon their relative

value to the organization. The comparison can be based upon the

level of contribution in terms of IT investments profitability.

Additionally, this comparison can also be based upon the non-

tangible factors such as organizations level of experience with a

certain technology, users familiarity with the applications and

infrastructure, and external forces such as emergence of newtechnologies and obsolesce of old ones.

(ii) Project Portfolio - This type of portfolio management speciallyaddress the issues with spending on the development of innovative

capabilities in terms of potential ROI and reducing investment

overlaps in situations where reorganization or acquisition occurs.

The management issues with the second type of portfoliomanagement can be judged in terms of data cleanliness, maintenance

savings, and suitability of resulting solution and the relative value of

new investments to replace these projects.

3.3 PROJECT PORTFOLIO MANAGEMENTProject portfolio management organizes a series of projects into a single

portfolio consisting of reports that capture project objectives, costs,timelines, accomplishments, resources, risks and other critical factors.


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19Executives can then regularly review entire portfolios, spread resourcesappropriately and adjust projects to produce the highest departmental

returns.

Project management is the discipline of planning, organizing and

managing resources to bring about the successful completion of specific

project goals and objectives.

A project is a finite endeavour (having specific start and completion

dates) undertaken to create a unique product or service which brings

about beneficial change or added value. This finite characteristic of

projects stands in contrast to processes, or operations, which are

permanent or semi-permanent functional work to repetitively produce the

same product or service. In practice, the management of these two

systems is often found to be quite different, and as such requires the

development of distinct technical skills and the adoption of separate

management.


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20CHAPTER: 4

PROCESS & TECHNIQUES

4.1 INVESTMENT DECISION4.2 FUNDAMENTAL ANALYSIS4.3 TIMING OF PURCHASES4.4 TECHNIQUES OF PORTFOLIO MANAGEMENT


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21There are three major activities involved in an efficient portfolio

management which are as follows:-

a) Identification of assets or securities, allocation of investment andalso identifying the classes of assets for the purpose of investment.

b)They have to decide the major weights, proportion of differentassets in the portfolio by taking in to consideration the related risk

factors.

c) Finally they select the security within the asset classes as identify.The above activities are directed to achieve the sole purpose of

maximizing return and minimizing risk on investment. It is well known

fact that portfolio manager balances the risk and return in a portfolio

investment. With higher risk higher return may be expected and vice

versa.

4.1 INVESTMENT DECISIONGiven a certain sum of funds, the investment decisions basically

depend upon the following factors:-

I. Objectives of Investment Portfolio:This is a crucial point which aFinance Manager must consider. There can be many objectives of

making an investment. The manager of a provident fund portfolio

has to look for security and may be satisfied with none too high a

return, where as an aggressive investment company is willing to take

high risk in order to have high capital appreciation.

How the objectives can affect in investment decision can be seen

from the fact that the Unit Trust of India has two major schemes: Its

capital units are meant for those who wish to have a good capital

appreciation and a moderate return, where as the ordinary unit are

meant to provide a steady return only. The investment manager

under both the scheme will invest the money of the Trust in different


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22kinds of shares and securities. So it is obvious that the objectivesmust be clearly defined before an investment decision is taken.

II. Selection of Investment: Having defined the objectives of theinvestment, the next decision is to decide the kind of investment to

be selected. The decision what to buy has to be seen in the context of

the following:-

a) There is a wide variety of investments available in market i.e.Equity shares, preference share, debentures, convertible bond,

Govt. securities and bond, capital units etc. Out of these what types

of securities to be purchased.

b)What should be the proportion of investment in fixed interestdividend securities and variable dividend bearing securities? The

fixed one ensures a definite return and thus a lower risk but the

return is usually not as higher as that from the variable dividend

bearing shares.

c) If the investment is decided in shares or debentures, then theindustries showing a potential in growth should be taken in first

line. Industry-wise-analysis is important since various industries

are not at the same level from the investment point of view. It is

important to recognize that at a particular point of time, a particular

industry may have a better growth potential than other industries.

For example, there was a time when jute industry was in greatfavour because of its growth potential and high profitability, the

industry is no longer at this point of time as a growth oriented

industry.

d)Once industries with high growth potential have been identified,the next step is to select the particular companies, in whose shares

or securities investments are to be made.


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234.2 FUNDAMENTAL ANALYSIS

(1) FUNDAMENTAL ANALYSIS OF GROWTH ORIENTED

COMPANIES:

One of the first decisions that an investment manager faces is to identify

the industries which have a high growth potential. Two approaches are

suggested in this regard. They are:

a) Statistical Analysis of Past Performance:A statistical analysis of the immediate past performance of the share price

indices of various industries and changes there in related to the generalprice index of shares of all industries should be made. The Reserve Bank

of India index numbers of security prices published every month in its

bulletin may be taken to represent the behaviour of share prices of various

industries in the last few years. The related changes in the price index of

each industry as compared with the changes in the average price index of

the shares of all industries would show those industries which are having

a higher growth potential in the past few years.

b)Assessing the Intrinsic Value of an Industry/Company:After an investment manager has identified statistically the industries in

the share of which the investors show interest, he would assess the

various factors which influence the value of a particular share. These

factors generally relate to the strengths and weaknesses of the company

under consideration, Characteristics of the industry within which the

company fails and the national and international economic scene. It is the

job of the investment manager to examine and weigh the various factors

and judge the quality of the share or the security under consideration.

This approach is known as the intrinsic value approach.


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24(2) INDUSTRY ANALYSIS

First of all, an assessment will have to be made regarding all the

conditions and factors relating to demand of the particular product, cost

structure of the industry and other economic and Government constraints

on the same. As we have discussed earlier, an appraisal of the particular

industrys prospectis essential and the basic profitability of any company

is dependent upon the economic prospect of the industry to which it

belongs. The following factors may particularly be kept in mind while

assessing to factors relating to an industry.

(i) Demand and Supply Pattern for the Industries Products and ItsGrowth Potential:The main important aspect is to see the likely

demand of the products of the industry and the gap between demand

and supply. This would reflect the future growth prospects of the

industry. In order to know the future volume and the value of the

output in the next ten years or so, the investment manager will have

to rely on the various demand forecasts made by various agencies

like the planning commission, Chambers of Commerce and

institutions like NCAER, etc.

(ii) Profitability:It is a vital consideration for the investors as profit isthe measure of performance and a source of earning for him. So the

cost structure of the industry as related to its sale price is an

important consideration. In India there are many industries which

have a growth potential on account of good demand position. The

other point to be considered is the ratio analysis, especially return on

investment, gross profit and net profit ratio of the existing companies

in the industry. This would give him an idea about the profitability

of the industry as a whole.


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25(iii) Particular Characteristics of the Industry: Each industry has its

own characteristics, which must be studied in depth in order to

understand their impact on the working of the industry. Because the

industry having a fast changing technology become obsolete at a

faster rate. Similarly, many industries are characterized by high rate

of profits and losses in alternate years. Such fluctuations in earnings

must be carefully examined.

(iv) Labour Management Relations in the Industry: The state oflabour-management relationship in the particular industry also has a

great deal of influence on the future profitability of the industry. The

investment manager should, therefore, see whether the industry

under analysis has been maintaining a cordial relationship between

labour and management.

(3)COMPANY ANALYSISTo select a company for investment purpose a number of qualitative

factors have to be seen. Before purchasing the shares of the company,

relevant information must be collected and properly analyzed. An

illustrative list of factors which help the analyst in taking the

investment decision is given below. However, it must be emphasized

that the past performance and information is relevant only to the extent it

indicates the future trends.1) Size and Ranking:A rough idea regarding the size and ranking of

the company within the economy, in general, and the industry, in

particular, would help the investment manager in assessing the risk

associated with the company. In this regard the net capital

employed, the net profits, the return on investment and the sales

volume of the company under consideration may be compared with

similar data of other company in the same industry group. It may


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26also be useful to assess the position of the company in terms oftechnical knowhow, research and development activity and price

leadership.

2)Growth Record: The growth in sales, net income, net capitalemployed and earnings per share of the company in the past few

years must be examined. The following three growth indicators

may be particularly looked in to (a) Price earnings ratio, (b)

Percentage growth rate of earnings per annum and (c)Percentage

growth rate of net block of the company. The price earnings ratio is

an important indicator for the investment manager since it shows

the number the times the earnings per share are covered by the

market price of a share. Theoretically, this ratio should be same for

two companies with similar features. However, this is not so in

practice due to many factors. Hence, by a comparison of this ratio

pertaining to different companies the investment manager can have

an idea about the image of the company and can determine whetherthe share is under-priced or over-priced. An evaluation of future

growth prospects of the company should be carefully made.

(4) FINANCIAL ANALYSIS:

An analysis of financial for the past few years would help the investment

manager in understanding the financial solvency and liquidity, theefficiency with which the funds are used, the profitability, the operating

efficiency and operating leverages of the company. For this purpose

certain fundamental ratios have to be calculated.

From the investment point of view, the most important figures are

earnings per share, price earnings ratios, yield, book value and the

intrinsic value of the share. The five elements may be calculated for the

past ten years or so and compared with similar ratios computed from the


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27financial accounts of other companies in the industry and with theaverage ratios of the industry as a whole. The yield and the asset backing

of a share are important considerations in a decision regarding whether

the particular market price of the share is proper or not.

(i) Quality of Management:This is an intangible factor. Yet it has avery important bearing on the value of the shares. Every investment

manager knows that the shares of certain business houses command

a higher premium than those of similar companies managed by other

business houses. This is because of the quality of management, the

confidence that the investors have in a particular business house, its

policy vis--vis its relationship with the investors, dividend and

financial performance record of other companies in the same group,

etc.

(ii) Location and labour management relations:The locations of thecompanys manufacturing facilities determine its economic viability

which depends on the availability of crucial inputs like power,skilled labour and raw materials etc. Nearness to market is also a

factor to be considered. In the past few years, the investment

manager has begun looking into the state of labour management

relations in the company under consideration and the area where it is

located.

(iii)

Pattern of Existing Stock Holding: An analysis of the pattern ofthe existing stock holdings of the company would also be relevant.

This would show the stake of various parties associated with the

company. An interesting case in this regard is that of the Punjab

National Bank in which the L.I.C. and other financial institutions

had substantial holdings. When the bank was nationalized, the

residual company proposed a scheme whereby those shareholders,

who wish to opt out, could receive a certain amount as compensation


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28in cash. It was only at the instant and bargaining strength ofinstitutional investors that the compensation offered to the

shareholders, who wish to opt out of the company, was raised

considerably.

(iv) Marketability of the Shares: Another important consideration foran investment manager is the marketability of the shares of the

company. Mere listing of the share on the stock exchange does not

automatically mean that the share can be sold or purchased at will.

There are many shares which remain inactive for long periods with

no transactions being affected.

Fundamental analysis thus is basically an examination of the economics

and financial aspects of a company with the aim of estimating future

earnings and dividend prospect. It included an analysis of the macro

economic and political factors which will have an impact on the

performance of the firm. After having analyzed all the relevant

information about the company and its relative strength vis--vis otherfirm in the industry, the investor is expected to decide whether he should

buy or sell the securities.

4.3 TIMING OF PURCHASESThe timing of dealings in the securities, specially shares is of crucial

importance, because after correctly identifying the companies one may

lose money if the timing is bad due to wide fluctuation in the price of

shares of that companies. The decision regarding timing of purchases is

particularly difficult because of certain psychological factors. It is

obvious that if a person wishes to make any gains, he should buy cheap

and sell dear, i.e. buy when the share are selling at a low price and sell

when they are at a higher price. But in practical it is a difficult task.


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29When the prices are rising in the market i.e. there is bull phase,everybody joins in buying without any delay because every day the prices

touch a new high. Later when the bear face starts, prices tumble down

every day and everybody starts counting the losses. The ordinary investor

regretted such situation by thinking why he did not sell his shares in

previous day and ultimately sell at a lower price. This kind of investment

decision is entirely devoid of any sense of timing.

4.4 TECHNIQUES OF PORTFOLIO MANAGEMENT

As of now the under noted technique of portfolio management: are in

vogue in our country.

1) Equity Portfolio: It is influenced by internal and external factorsthe internal factors affect the inner working of the companys

growth plans are analyzed with referenced to Balance sheet, profit

& loss a/c (account) of the company.

Among the external factor are changes in the government policies,

Trade cycles, Political stability etc.

2) Equity Stock Analysis: Under this method the probable futurevalue of a share of a company is determined it can be done by

ratios of earning per share of the company and price earnings ratio

EARNING PER SHARE = PROFIT AFTER TAX

NO. OF EQUITY SHARES

PRICE EARNING RATIO = MARKET PRICE (PER SHARE)

EARNING PER SHARE


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30One can estimate trend of earning by EPS, which reflects trends of earningquality of company, dividend policy, and quality of management. Price

Earnings ratio indicate a confidence of market about the company future, a

high rating is preferable.

The following points must be considered by portfolio managers while

analyzing the securities.

1) Nature of the industry and its product: Long term trends ofindustries, competition within, and outside the industry, Technical

changes, labour relations, sensitivity, to Trade cycle.2) Industrial analysis of prospective earnings, cash flows, working

capital, dividends, etc.

3) Ratio analysis: Ratios such as debt equity ratio, current ratio, networth, profit earnings ratio, returns on investment, are worked out

to decide the portfolio.

The wise principle of portfolio management suggests that Buy when the

market is low or BEARISH, and sell when the market is rising or

BULLISH.

Stock market operation can be analyzed by:

a) Fundamental approach: - Based on intrinsic value of shares.b)

Technical approach: - Based on Dow Joness Theory, RandomWalk Theory, etc.

Prices are based upon demand and supply of the market .

Objectives are maximization of wealth and minimization of risk. Diversification reduces risk and volatility. Variable returns, high illiquidity; etc.


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31In short we can conclude by saying that Investment management is a

complex activity which may be broken down into the following steps:

1) Specification Of Investment Objectives And Constraints:The typical objectives sought by investors are current income,

capital appreciation, and safety of principle. The relative importance

of these objectives should be specified further the constraints arising

from liquidity, time horizon, tax and special circumstances must be

identified.

2) Choice Of The Asset Mix :The most important decision in portfolio management is the asset

mix decision very broadly; this is concerned with the proportions of

stocks (equity shares and units/shares of equity-oriented mutual

funds) and bonds in the portfolio.

The appropriate stock-bond mix depends mainly on the risk

tolerance and investment horizon of the investor.


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32CHAPTER: 5

PORTFOLIO THEORIES

5.1 DOW JONES THEORY5.2 RANDOM WALK THEORY5.3 CAPITAL ASSETS PRICING MODEL (CAPM)5.4 MOVING AVERAGE5.5 MODERN PORTFOLIO THEORY5.6 MARKOWITZ THEORY5.7 SHARPES THEORY


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335.1 DOW JONES THEORY

The DOW JONES THEORY is probably the most popular theory

regarding the behaviour of stock market prices. The theory derives its

name from Charles H. Dow, who established the Dow Jones & Co. and

was the first editor of the Wall Street Journal a leading publication on

financial and economic matters in the U.S.A. Although Dow never gave a

proper shape to the theory, ideas have been expanded and articulated by

many of his successors.

The Dow Jones theory classifies the movement of the prices on the share

market into three major categories:

1. Primary Movements,2. Secondary Movements3. Dail y F luctuations.1) Primary Movements: They reflect the trend of the stock market

and last from one year to three years, or sometimes even more. If

the long range behaviour of market prices is seen, it will be

observed that the share markets go through definite phases where

the prices are consistently rising or falling. These phases are known

as bull and bear phases.

P3

P2

P1 T3

T2

T1 Graph 1


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34During a bull phase, the basic trend is that of rise in prices. Graph 1above shows the behaviour of stock market prices in bull phase.

You would notice from the graph that although the prices fall after

each rise, the basic trend is that of rising prices. As can be seen from

the graph that each trough prices reach, is at a higher level than the

earlier one. Similarly, each peak that the prices reach is on a higher

level than the earlier one. Thus P2 is higher than P1 and T2 is higher

than T1. This means that prices do not rise consistently even in a bull

phase. They rise for some time and after each rise, they fall. However,

the falls are of a lower magnitude then earlier. As a result, prices reach

higher levels with each rise.

Once the prices have risen very high, the bear phase in bound to

start i.e., price will start falling. Graph 2 shows the typical behaviour

of prices on the stock exchange in the case of a

P3

P2

T1 P1

T2

T3

Graph 2

Bear phase. It would be seen that prices are not falling consistently

and, after each fall, there is a rise in prices. However, the rise is not

much as to take the prices higher than the previous peak. It means that

each peak and trough is now lower than the previous peak and trough.


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35The theory argues that primary movements indicate basic trends inthe market. It states that if cyclical swings of stock market prices

indices are successively higher, the market trend is up and there is a

bull market. On the contrary, if successive highs and low are

successively lower, the market is on a downward trend and we are in

bear market. This theory thus relies upon behaviour of the indices of

share market prices in perceiving the trend in the market.

2) Secondary Movements:We have seen that even when the primarytrend is upward, there are also downward movements of prices.

Similarly, even where the primary trend is downward, there is

upward movement of prices also. These movements are known as

secondary movements and are shorter in duration and are opposite

in direction to the primary movements. These movements normally

last from three weeks to three months and retrace 1/3 to 2/3 of the

previous advance in a bull market of previous fall in the bear

market.3) Daily Movements: There are irregular fluctuations which occur

every day in the market. These fluctuations are without any definite

trend. Thus is the daily share market price index for a few months

are plotted on the graph it will show both upward and downward

fluctuations. These fluctuations are the result of speculative factor.

An investment manger really is not interested in the short runfluctuations in share prices since he is not a speculator. It may be

reiterated that anyone who tries to gain from short run fluctuations

in the stock market, can make money only be sheer chance. The

investment manager should scrupulously keep away from the daily

fluctuations of the market. He is not a speculator and should

always resist the temptation of speculating. Such a temptation is


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36always very attractive but must always be resisted. Speculation isbeyond the scope of the job of an investment manager.

Timing of investment decisions on the basis of Dow Jones Theory:

Ideally speaking the investment manage would like to purchase shares at

a time when they have reached the lowest trough and sell them at a time

when they reach the highest peak. However, in practice, this seldom

happens. Even the most astute investment manager can never know when

the highest peak or the lowest through have been reached. Therefore, he

has to time his decision in such a manner that he buys the shares whenthey are on the rise and sells then when they are on the fall. It means that

he should be able to identify exactly when the falling or the rising trend

has begun.

This is technically known as identification of the turn in the share market

prices. Identification of this turn is difficult in practice because of the fact

that, even in a rising market, prices keep on falling as a part of the

secondary movement. Similarly even in a falling market prices keep on

rising temporarily. How to be certain that the rise in prices or fall in the

same in due to a real turn in prices from a bullish to a bearish phase or

vice versa or that it is due only to short run speculative trends?

Dow Jones Theory identifies the turn in the market prices by seeing

whether the successive peaks and troughs are higher or lower than earlier.

5.2 RANDOM WALK THEORYSamuelson has proved in 1965 that if a market has zero

transaction costs, if all available information is free to all interested

parties, and if all market participants and potential participants have

the same horizons and expectations about prices, the market will be

efficient and prices will fluctuate randomly.


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37According to the Random Walk Theory, the changes in prices of stockshow independent behaviour and are dependent on the new pieces of

information that are received but within themselves are independent of

each other. Whenever a new price of information is received in the stock

market, the market independently receives this information and it is

independent and separate from all the other prices of information. For

example, a stock is selling at Rs. 40 based on existing information known

to all investors. Afterwards, the news of a strike in that company will

bring down the stock price to Rs. 30 the next day. The stock price further

goes down to Rs. 25. Thus, the first fall in stock price from Rs. 40 to Rs.

30 is caused because of some information about the strike. But the second

fall in the price of a stock from Rs. 30 to Rs. 25 is due to additional

information on the type of strike. Therefore, each price change is

independent of the other because each information has been taken in, by

the stock market and separately disseminated. However, independent

pieces of information, when they come together immediately after eachother show that the price is falling but each price fall is independent of the

other price fall.

The basic essential fact of the Random Walk Theory is that the

information on stock prices is immediately and fully spread over that other

investors have full knowledge of the information. The response makes the

movement of prices independent of each other. Thus, it may be said thatthe prices have an independent nature and therefore, the price of each day

is different. The theory further states that the financial markets are so

competitive that there is immediate price adjustment. It is due to the

effective communication system through which information can be

disturbed almost anywhere in the country. This speed of information

determines the efficiency of the market.


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385.3 CAPITAL ASSETS PRICING MODEL (CAPM)

CAPM provides a conceptual framework for evaluating any investment

decision. It is used to estimate the expected return of any portfolio with

the following formula:

E (Rp) = Rf +Bp (E (Rm)Rf)

Where,

E (Rp) = Expected return of the portfolio

Rf = Risk free rate of return

Bp = Beta portfolio i.e. market sensitivity index

E (Rm) = Expected return on market portfolio

[E (Rm)-Rf] = Market risk premium

The above model of portfolio management can be used effectively to:-

Estimate the required rate of return to investors on companyscommon stock.

Evaluate risky investment projects involving real Assets. Explain why the use of borrowed fund increases the risk and

increases the rate of return.

Reduce the risk of the firm by diversifying its project portfolio.5.4 MOVING AVERAGE

It refers to the mean of the closing price which changes constantly and

moves ahead in time, there by encompasses the most recent days and

deletes the old one.

5.5 MODERN PORTFOLIO THEORYModern Portfolio Theory quantifies the relationship between risk and

return and assumes that an investor must be compensated for assumingrisk. It believes in the maximization of return through a combination of


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39securities. The theory states that by combining securities of low risks withsecurities of high risks success can be achieved in making a choice of

investments. There can be various combinations of securities. The

modern theory points out that the risk of portfolio can be reduced by

diversification. Harry Markowitzand William Sharpehave developed

this theory.

5.6 MARKOWITZ THEORYMarkowitz has suggested a systematic search for optimal portfolio.

According to him, the portfolio manager has to make probabilistic

estimates of the future performances of the securities and analyse these

estimates to determine an efficient set of portfolios. Then the optimum set

of portfolio can be selected in order to suit the needs of the investors. The

following are the assumptions of Markowitz Theory:

Investors make decisions on the basis of expected utilitymaximization.

In an efficient market, all investors react with full facts aboutall securities in the market.

Investors utility is the function of risk and return onsecurities.

The security returns are co-related to each other by combiningthe different securities.

The combination of securities is made in such a way that theinvestor gets maximum return with minimum of risk.

An efficient portfolio exists, when there is lowest level of riskfor a specified level of expected return and highest expected

return for a specified amount of portfolio risk.

The risk of portfolio can be reduced by adding investments inthe portfolio.


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405.7 SHARPES THEORY

William Sharpe has suggested a simplified method of diversification of

portfolios. He has made the estimates of the expected return and variance

of indexes which are related to economic activity. Sharpes Theory

assumes that securities returns are related to each other only through

common relationships with basic underlying factor i.e. market return

index. Individual securities return is determined solely by random factors

and on its relationship to this underlying factor with the following

formula:

Ri = ai + BiI + ei

Where, Rirefers to expected return on security

ai =the intercept of a straight line or alpha coefficient

Bi=slope of straight-line or beta coefficient

I =level of market return index

ei =error, i.e. residual risk of the company.


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41CHAPTER - 6

INVESTMENT ANALYSIS

6.1 MEANING OF INVESTMENT

6.2 INVESTMENT AVENUES

6.3 NEW ISSUES MARKETINVESTMENT DECISION

6.4 STOCK MARKETINVESTMENT DECISION

6.5 GUIDELINES FOR INVESTORS

6.6 INVESTMENT STRATEGY

6.7 INVESTMENT AND SPECULATION

6.8 ELEMENTS OF INVESTMENTS

6.9 RULES TO BE FOLLOWED BEFORE

INVESTMENT IN PORTFOLIOS


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426.1 MEANING OF INVESTMENT

Investment means employment of funds in a productive manner so as

to create additional income. The word investment means many things tomany persons. Investment in financial assets leads to further production

and income. It is lending of funds for income and commitment of money

for creation of assets, producing further income.

Investment also means purchasing of securities, financial instruments

or claims on future income. Investment is made out of income and

savings credit or borrowings and out of wealth. It is a reward for waiting

for money.

There are two concepts of investment:

1) Economic Investment: The concept of economic investmentmeans additions to the capital stock of the society. The capital

stock of society is the goods which are used in the production of

other goods. The term investment implies the formation of new and

productive capital in the form of new construction and producers

durable instrument such as plant and machinery, inventories and

human capital are also included in this concept. Thus, an

investment, in economic terms, means an increase in building,

equipment, and inventory.

2) Financial Investment: This is an allocation of monetary resourcesto assets that are expected to yield some gain or return over a given

period of time. It is a general or extended sense of the term. It

means an exchange of financial claims such as shares and bonds,

real estate, etc. in their view; investment is a commitment of funds

to derive future income in the form of interest, dividends, rent


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43premiums, pension benefits and the appreciation of the value oftheir principal capital.

The economic and financial concepts of investment are

related to each other because investment is a part of the savings of

individuals which flow into the capital market either directly or

through institutions. Thus, investment decisions and financial

decisions interact with each other. Financial decisions are primarily

concerned with the sources of money where as investment

decisions are traditionally concerned with uses or budgeting of

money.

6.2 INVESTMENT AVENUES

The alternative investment avenues for the investor are to be

considered first so as to satisfy the above objectives of investors. The

following categories of investors are open to investors as avenues for

savings to flow in financial form:

(a)Investment in Bank Deposits Savings And Fixed Deposits:This is the most common form of investment for an average Indian

and nearly 40% of funds in financial savings are used in this form

these are least risky but the return is also low.


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44(b)Investment in P.O. Deposits, National Savings Certificates and

other Postal Savings Schemes:Many people in villages and some

urban areas are investors in these schemes due to lower risk of loss

of money and greater security of funds. But returns are also lower

than in Stocks & Shares.

(c)Insurance Schemes of LIC/GIC etc. and Provident and PensionFunds:About 20-25% of financial savings of the household sector

are put in these forms and P.F., Pension and other forms of

contractual savings.

(d)Investment in Mutual Fund Schemes or UTI Schemes as andwhen announced: These are less risky than direct investment in

stocks and shares as these enjoy the expert management by the

Portfolio Manager or Professional experts. They also have the

advantage of diversified Portfolio involving the reduction of risk

and economies of scale reducing the cost of investment.

(e)Investment in New Issues Market: A new entrant in the StockMarket should preferably invest in New Issues of existing and well

reputed companies either in equity or debentures. Incidentally the

instruments in which investment can be made in the new issues

market are :

1. Equity issues through prospectus or rights announced byexisting shareholders.

2. Preference shares with a fixed dividend either convertibleinto equity or not.

3. Debentures of various categories convertible, fullyconvertible, partly convertible and non- convertible

debentures.

4. P.S.U. Bondstaxable or free-taxed with interest rates.(f)Investment in gold, silver, precious metals and antiques.


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45(g)Investment in real estates.(h)Investment in gilt-edged securities and securities of Government

and Semi-Government organizations (e.g. Relief bonds, bonds of

port trusts, treasury bills, etc.). The maturity period is varying

generally upto10 to20 years. Gilt-edged securities market

constitutes the largest segment of the Indian capital market. These

are fully secured as they have government backing. Tax benefits

are available to these securities.

The following figure indicates alternative avenues for

Investment:

Investment

Avenues

National &

Postal

Savings

SchemesPF & PPF

LIC

Schemes

UTI &

Mutual

Funds

Shares &Debentures

Gold and

Silver

Real

Estates

Money

Market

Securities

GOI

Savings

Bonds

Public

Deposits

Bank

Deposits


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466.3 NEW ISSUES MARKETINVESTMENT DECISION

Investors would prefer debentures if they are interested in a fixed

income. They may go for convertible debentures, if they want to haveboth fixed income and likely capital appreciation in future. If they are risk

taking and aim only at capital gains, then they may invest in equity

shares. In choosing the new issues for investment decision, the investor

has to read a copy of the prospectus and note the following:

1. Who are the promoters and their past record?2. Products manufactured and demand for those products at home or

abroadthe competitors and the share of each in the market.

3. Availability of inputs, raw materials and accessories and thedependence on imports.

4. Project location and its advantages.5. Prospects through projected earnings, net profits and dividend

paying capacity, waiting period involved, etc.If the new issues belong to a company promoted by well known

Business Groups like Tatas, Birlas etc. they are less risky. The company

should belong to an industry which is expanding and has good potential

like drugs, chemicals, Telecom etc. the terms of offer should be attractive

like conversion or immediate prospects of dividend etc.

6.4 STOCK MARKETINVESTMENT DECISION

As far as the stock market is concerned, investment in shares is most

risky as the likelihood of fall or rise in prices is uncertain. But the returns

may also be high commensurate with risk. A host of imponderable factors

operate in the stock market and a genuine investor has to do the following

things:


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47Study the Balance Sheet of the company and analyze the prospects ofsales and profits.

1. Analyze the market price in terms of book value and profit earningcapacity (or P/E Ratio) and use them to know whether the share is

overvalued or undervalued.

2. Study the expansion plans or tax savings plans and analyze thecompanys financial strength, bonus and dividend paying strength,

through the mechanism of financial ratios.

3. Study whether the management is professional and good, whetherother accounting practices are dependable and consistent. The

company becomes attractive to buy if the financial ratios support

the view that the fundamentals are strong and the shares are worth

buying.

4. Lastly, if the price of the share is undervalued on the basis of theprojected earnings for the coming half year or one year and its P/E

Ratio is below the industry average, then it is worth buying. Thesame is worth selling if in his judgement it is overhauled. For

assessing the under valuation and over valuation, the analyst and

his analytical power count for this purpose.

6.5 GUIDELINES FOR INVESTORS

1.Never buy on rumours or market gossip.2. Buy only on the basis of fundamental analysis of the companies

based on balance sheet data analysis.

3. Buy a diversified list of companies and not put all the money inone or two companies. All investments in the stock market are

risky. The risk can be reduced by proper diversification of the

portfolio into 10 or 15 companies.


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484. Study the sales, gross profit, net profit in relation to equity capital

employed and attempts a forecast for the coming half year or one

year.

5. A declaration of bonus or low P/E ratio, along with strongfundamentals shows that the company should be a good buy.

6. The investor should also watch for low priced shares which areabout to turn around for more profitability in future.

7. Investors should buy on declines and follow the principle ofcontrariness. This means that if everyone is buying scrip, avoid that

scrip but if a scrip is deserted and your study has shown that is has

potential; for expanding earnings and profitability, then such

scrips should be purchased by the investor.

8. Avoid both fear and greed on the stock market. If investor is notafraid of the market, he generally studies the market and buys at

lows and sells at highs.

9. The investor should know how to analyze the security prices ofcompanies and pick up the undervalued shares. Timing of purchase

and sale is also very important. If technical analysis and the use of

charts are not familiar to the investor he should follow the principle

buy low and sell high. He should see whether there is a bull

market or bear market in a share by a study of the share price over

a period of 15 to 30 days. In a bull phase one can sell at one of thepeaks and in a bear phase one can buy at one of troughs

The investors should not do the following things:

1) He should not put all his eggs in one basket which means that heshould not put all his funds in one or two companies.

2) Do not go by heresy or rumours to buy or sell scrip as that might be adupe.


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493) Do not speculate involving the buying and selling in the same day or

during the same settlement period. A long term investor gains more

than speculator.

4) Avoid taking undue risks or beyond the capacity of your net worth.That means if capital base is Rs. 2 lacs, put a stop loss order at Rs.

20,000/- (or 1/8thor 1/10

thof the capital base).

5) Do not get panicky if the scrip in which you have invested go down inprice. Once the investment is made after a study of fundamentals, a

temporary fall in its price should not cause worry. What the investor

needs is patience, which is possible if he is a longterm investor.

6) Do not be too greedy or ambitious. Put limits to your operations andbuy and sell orders in a price range and your minimum profit limit is

20%.

6.6 INVESTMENT STRATEGY

Portfolio management can be practiced by following either an active or

passive strategy.

Active strategy is based on the assumption that it is possible to beat the

market. This is done by selecting assets that are viewed as under priced or

by changing the asset mix or proportion of fixed income securities and

shares. Active strategy is carried out as follows:

1) Aggressive Security Management: Aggressive purchasing andselling of securities to achieve high yields from dividend interest

and capital gains.

2) Speculation and Short Term Trading: The objective is to gaincapital profits. The risk is high and the composition of portfolio is

flexible. Success of active strategy depends on correct decisions as

regard the timing of movement in the market as a whole, weight


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50age of various securities in the portfolio and individual shareselection.

The passive strategy does not aim at outperforming the market. Unlike

the active strategy. On the other hand the stocks could be randomly

selected on the assumption of a perfectly efficient market. The objective

is to include in the portfolio a large number of securities so as to reduce

risks specific to individual securities. The characteristics of positive

strategy are:

1. Long Term Investment Horizon2. Little Portfolio Revisions

Thus it is basically a buy and hold strategy.

The strategy can be implemented by investing in securities so as to

duplicate the portfolio of a market index which is called indexing.

6.7 INVESTMENT AND SPECULATION

Speculation is an activity, quite contrary to its literal meaning, in

which a person assumes high risks, often without regard for the safety of

his invested principal, to achieve large capital gains. The time span in

which the gain is sought to be made is usually very short.

The investor sacrifices some money today in anticipation of a financial

return in future. He indulges in a bit of speculation. There is an element

of speculation involved in all investment decisions. However it does not

mean that all investments are speculative by nature. Genuine investments

are carefully thought out decisions. On the other hand, speculative

investments are not carefully thought out decisions. They are based on

tips and rumours.

An investment can be distinguished from speculation in three ways

Risk, capital gain and time period. Investment involves limited risk

while speculation is considered as an investment of funds with high risk.


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51The purchase of a security for earning a stable return over a period oftime is an investment whereas the primary motive is to earn high profits

through price changes is termed as speculation. Thus, speculation

involves buying a security at low price and selling at a high price to make

a capital gain.

The truth is that any investment is a speculation if the investor uses his

judgement and forecast the probable course of events in order to reap the

returns on his investment.

6.8 ELEMENTS OF INVESTMENTS

(a)Return:Investors buy or sell financial instruments in order to earnreturn on them. The return on investment is the reward to the

investors. The return includes both current income and capital

gains or losses, which arises by the increase or decrease of the

security price.

(b)Risk:Risk is the chance of loss due to variability of returns on aninvestment. In case of every investment, there is a chance of loss. It

may be loss of interest, dividend or principal amount of

investment. However, risk and return are inseparable. Return is a

precise statistical term and it is measurable. But the risk is not

precise statistical term. However, the risk can be quantified: The

investment process should be considered in terms of both risk and

return.

(c)Time: Time is an important factor in investment. It offers severaldifferent courses of action. Time period depends on the attitude of

the investor who follows a buy and hold policy. As time moves

on, analysts believe that conditions may change and investors may

revaluate expected return and risk for each investment.


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526.9 RULES TO BE FOLLOWED BEFORE

INVESTMENT IN PORTFOLIOS

1) Compile the financials of the companies in the immediate past 3years such as turnover, gross profit, net profit before tax, compare

the profit earning of company with that of the industry average

nature of product manufacture service render and it future demand

,know about the promoters and their back ground, dividend track

record, bonus shares in the past 3 to 5 years ,reflects companys

commitment to share holders the relevant information can beaccessed from the RDC (Registrant of Companies) published

financial results financed quarters, journals and ledgers.

2) Watch out the highs and lows of the scripts for the past 2 to 3years and their timing cyclical scripts have a tendency to repeat

their performance, this hypothesis can be true of all other

financial,

3) The higher the trading volume higher is liquidity and still higherthe chance of speculation, it is futile to invest in such shares whos

daily movements cannot be kept track, if you want to reap rich

returns keep investment over along horizon and it will offset the

wild intraday trading fluctuations, the minor movement of scripts

may be ignored, we must remember that share market moves in

phases and the span of each phase is 6 months to 5 years.


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53CHAPTER - 7

RISKRETURN ANALYSIS

7.1 RISKS ON PORTFOLIO

7.2 TYPES OF RISK

7.3 RISK RETURN ANALYSIS

7.4 RETURNS ON PORTFOLIO


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547.1 RISKS ON PORTFOLIO

The expected returns from individual securities carry some degree of

risk. Risk on the portfolio is different from the risk on individual

securities. The risk is reflected in the variability of the returns from zero to

infinity. Risk of the individual assets or a portfolio is measured by the

variance of its return. The expected return depends on the probability of

the returns and their weighted contribution to the risk of the portfolio.

These are two measures of risk in this context one is the absolute deviation

and other standard deviation.

Most investors invest in a portfolio of assets, because as to spread risk

by not putting all eggs in one basket. Hence, what really matters to them

are not the risk and return of stocks in isolation, but the risk and return of

the portfolio as a whole. Risk is mainly reduced by Diversification.

7.2 TYPES OF RISK

1) Interest Rate Risk: This arises due to the variability in the interestrates from time to time. A change in the interest rate establishes an

inverse relationship in the price of the security i.e. price of the

security tends to move inversely with change in rate of interest, long

term securities show greater variability in the price with respect to

interest rate changes than short term securities.

Interest rate risk vulnerability for different securities is as under:

TYPES RISK EXTENT

Cash Equivalent Less vulnerable to interest rate

risk.

Long Term Bonds More vulnerable to interest rate

risk.


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552) Purchasing Power Risk: It is also known as inflation risk also

emanates from the very fact that inflation affects the purchasing

power adversely. Nominal return contains both the real return

component and an inflation premium in a transaction involving risk

of the above type to compensate for inflation over an investment

holding period. Inflation rates vary over time and investors are

caught unaware when rate of inflation changes unexpectedly

causing erosion in the value of realized rate of return and expected

return.

Purchasing power risk is more in inflationary conditions especially

in respect of bonds and fixed income securities. It is not desirable

to invest in such securities during inflationary periods. Purchasing

power risk is however, less in flexible income securities like equity

shares or common stock where rise in dividend income off-sets

increase in the rate of inflation and provides advantage of capital

gains.3) Business Risk:Business risk emanates from sale and purchase of

securities affected by business cycles, technological changes etc.

Business cycles affect all types of securities i.e. there is cheerful

movement in boom due to bullish trend in stock prices whereas

bearish trend in depression brings down fall in the prices of all

types of securities during depression due to decline in their marketprice.

4) Financial Risk:It arises due to changes in the capital structure ofthe company. It is also known as leveraged risk and expressed in

terms of debt-equity ratio. Excess of risk vis--vis equity in the

capital structure indicates that the company is highly geared.

Although a leveraged companys earnings per share are more but

dependence on borrowings exposes it to risk of winding up for its


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56inability to honour its commitments towards lender or creditors. Therisk is known as leveraged or financial risk of which investors

should be aware and portfolio managers should be very careful.

5) Systematic Risk or Market Related Risk: Systematic risksaffected from the entire market are (the problems, raw material

availability, tax policy or government policy, inflation risk, interest

risk and financial risk). It is managed by the use of Beta of different

company shares.

6) Unsystematic Risks: The unsystematic risks are mismanagement,increasing inventory, wrong financial policy, defective marketing

etc. this is diversifiable or avoidable because it is possible to

eliminate or diversify away this component of risk to a

considerable extent by investing in a large portfolio of securities.

The unsystematic risk stems from inefficiency magnitude of those

factors different form one company to another.

7.3 RISK RETURN ANALYSIS

All investment has some risk. Investment in shares of companies has

its own risk or uncertainty; these risks arise out of variability of yields and

uncertainty of appreciation or depreciation of share prices, losses of

liquidity etc

The r isk over time can be represented by the variance of the returns

while the return over timeis capital appreciation plus payout, divided by

the purchase price of the share.


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57

Normally, the higher the risk that the investor takes, the higher is the

return. There is, however, a risk less return on capital of about 12% which

is the bank, rate charged by the R.B.I or long term, yielded on

government securities at around 13% to 14%. This risk less return refers

to lack of variability of return and no uncertainty in the repayment or

capital. But other risks such as loss of liquidity due to parting with moneyetc., may however remain, but are rewarded by the total return on the

capital.

Risk-return is subject to variation and the objectives of the portfolio

manager are to reduce that variability and thus reduce the risk by choosing

an appropriate portfolio.

Traditional approach advocates that one security holds the better, it is

according to the modern approach diversification should not be quantity

that should be related to the quality of scripts which leads to quality of

portfolio.

Experience has shown that beyond the certain securities by adding

more securities expensive.


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587.4 RETURNS ON PORTFOLIO

Each security in a portfolio contributes return in the proportion of its

investments in security. Thus the portfolio expected return is the weightedaverage of the expected return, from each of the securities, with weights

representing the proportions share of the security in the total investment.

Why does an investor have so many securities in his portfolio? If the

security ABC gives the maximum return why not he invests in that

security all his funds and thus maximize return? The answer to this

questions lie in the investors perception of risk attached to investments,

his objectives of income, safety, appreciation, liquidity and hedge against

loss of value of money etc. this pattern of investment in different asset

categories, types of investment, etc., would all be described under the

caption of diversification, which aims at the reduction or even elimination

of non-systematic risks and achieve the specific objectives of investors.


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59CHAPTER 8

ASSET ALLOCATION

8.1 SECURITY SELECTION

8.2 BASIS OF SELECTION OF EQUITY PORTFOLIO

8.3 DIVERSIFICATION


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60The portfolio manager has to invest in these securities that form the

optimal portfolio. Once a portfolio is selected the next step is the

selection of the specific assets to be included in the portfolio. Assets in

this respect means group of security or type of investment. While

selecting the assets the portfolio manager has to make asset allocation.

PORTFOLIO MGT 100 MRKS PROJECT FOR BBI 5TH SEM

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